What are the warning signs of a business in financial distress?

UK-based financial and business advisors Company Rescue discuss the warning signs that indicate a business in trouble, and how employees or senior staff can notice such signs at an early or preventative stage.

In business, when you rely on suppliers supplying you and customers paying you, it is important to be able to recognize signs of distress in other businesses. The problem is that you have limited information, except that they are perhaps not paying on time. You may also refer to credit rating agencies, but would you recognize all the signs of distress in your own business? Please read this guide of all the warning signs – it is not exhaustive, and if you think that there are more, then please let us know.

The bank

Perhaps the most obvious sign of distress in a business is the behaviour of their bank. Do they seem worried?

Are they looking for extra security, such as personal guarantees or debentures?

Are they withdrawing overdrafts and refusing loans?

Are they generally asking for lots of information?

Reporting and filing

The business has not filed the company’s accounts on time, and has incurred a penalty

The business has not filed the company’s annual return

OK – they don’t seem important, but if the company is not able to comply with some simple statutory obligations that outline its financial position, then it may be in denial, or those in charge are simply fighting on other issues.

What about your creditors?

You find it difficult to pay creditors on time, and so your supply line is disrupted. Your business is using credit by what is called “Peter and Paul-ing” – you are using lots of suppliers to obtain new credit

The company’s creditor days are growing (divide the amount of money you owe creditors by the sales per annum and multiply by 365)

The directors are always fighting creditor fires and having to handle creditors calls every day

Suppliers can’t obtain trade insurance against your company – in some cases this can be the straw that breaks the camel’s back, because once this trade insurance is withdrawn, then all suppliers will stop supplying. This is in effect what happened to UK high street retailer Woolworths back in 2008

The problem with creditor pressure is that it distracts the management away from actually running the business to pay back the creditors, so it can be a vicious circle that often leads to insolvency.

Debtors

Believe it or not, lots of businesses only get into trouble as they are not collecting in debts as quickly as they should. One sure indicator of this is that the business doesn’t actually know what its total number of debtors is. Another risk factor is where the company has concentration in one or two major customers (debtors). It only takes a dispute with one of them, or one of the customers to get into its own financial difficulties, for the business to be in real danger.

Other indicators may be as follows:

You are reluctant to issue credit notes

The accounts department only invoices periodically

There is no dedicated debtor collection function

Factoring companies

Factoring companies can be very useful at helping a company’s cashflow, but they can also get quite tough with companies that may be in distress. They tend to go about this in the following ways:

They start reducing the advance

They don’t seem to understand your business

You can never get enough advance against your invoices

They are advancing 75 percent against the business’s invoices but disallowing lots of them

They claw money back from you after the debtor has not paid in less than 90 days

Management warning signs

Often it is the behaviour of management that is a give away, so check that you or the management team are not doing the following all the time:

Concentrating on non-essential issues

Senior people seem paralysed into inaction

Is the team “compartmentalising” problems? (in other words he or she deals with one creditor problem and ignores others)

They don’t have regular meetings

They have overdrawn director’s accounts – taking dividends when no profits in the business

Do management blame the:

Bank

Creditors

Debtors

Accountants (ie you!)

Advisors

Everyone(!)

Financial information is everything. So often we see businesses that become insolvent due to lack of good financial information (in almost 80 percent of cases). This is the biggest single cause of insolvency and the accompanying stress. It is even possible to be growing rapidly, making lots of profits, but actually suffer a cash crunch that can put the company down.

Only good financial information can prevent this, and can ensure that costs are cut quickly enough and problem areas identified. A company can downsize without the associated stress if the information is at hand. Of course, poor financial information is an indicator of systemic problems with management. So what should you look out for?

The directors and management don’t know:

Gross Profit – accurately

Costs – accurately

Sales per month/per annum

Orders taken

Enquiries quoted for

Bank balances

Where 80 percent of work comes from

Where 80 percent of profit comes from

What their annual accounts mean – they are “wrong” usually

Their market – who are the main competitors, products and threats?

How many units of your products you make per day

How much units made per day cost

How many units the company needs to make to break even

How many enquiries the company needs

How many enquiries the company converts into sales

How many people it takes to make this product

Sales performance compared to last year/last month/budget

Cost increases/decreases year-on-year

The list can go on and on, and problems with staff morale, politics, or high staff turnover are also indicative of distress.

2. Financing

Another relatively obvious area would be financing:

Always refinancing assets – no money to pay deposits

Just need a certain amount of money to sort a problem

The next big sale/contract/debtor payment will sort the problem out

The business has introduced a number of new financial products to keep going

The business has borrowed money against homes to fund the business

Directors are not taking money out of the business to live

In conclusion, the warning signs are many, and a few of the items listed happen in all businesses, including some that are performing well. However, some are more critical warnings than others.

So if you want five top warning signs, here they are:

Use of tax due to tax payments being used for working capital

You think that one more sale, one more contract, one big customer payment will solve the cash flow problem (it won’t)

You have overdrawn the director’s current accounts (see a guide to this issue here)

You spread credit around with lots of different suppliers

You have poor financial records and cannot quickly figure out how much you owe and how much is owed to you

You will know it in your gut when the problems are too many. However, after many years of dealing with distressed companies, the frustrating thing is that many businesses could have been saved if they had recognized the warning signs earlier and taken professional advice.